The Institute of Economic Affairs is best known for publishing books about the free market, but this particular work is about improving the efficiency of nationalised industries. To be exact, it argues that some countries would be better off if they imported the product of a foreign nationalised industry than if they used the product of a domestic nationalised industry. The product in question is money. According to Kurt Schuler, central banking in developing countries has usually failed to provide sound money, and those countries should seriously consider either using a foreign currency or linking their own currency to that of a more advanced country.

Dr Schuler has carried out a thorough study of the monetary history of every country in the world, whether independent or not, which existed as a separate political unit at any time between 1951 and 1993 and had at least a million inhabitants in 1993. (Countries with less than a million people account for less than 1 per cent of the world's population and less than 1 per cent of its economic output.) Out of the 155 countries in his study, he counts 136 as developing (including all the communist and ex-communist countries as well as the Third World) and 19 as developed. All the developed countries had central banking throughout the period in question, but many of the developing countries did not. In an Appendix which takes up more than half the book, he presents data on economic growth and several different measures of currency quality, including inflation, convertibility, the rate of exchange with the US dollar, and currency confiscations (in which an old currency was replaced by a new one at different rates of exchange for different amounts). He concludes that, by all these standards, central banking in developing countries has performed worse than central banking in developed countries and worse than other monetary systems in developing countries.

The alternatives to central banking which Dr Schuler discusses include foreign currency (formerly used in several independent nations as well as colonies), and a number of systems in which the domestic currency is linked to a foreign anchor currency at a fixed exchange rate. These include currency boards, monetary institutes and private banking monopolies. Currency boards, which were formerly common in British colonies, are state institutions which issue currency backed 100 per cent by assets in a foreign currency with which they are required to maintain convertibility at a fixed rate. Unlike central banks, they cannot conduct open-market operations or impose reserve ratios on banks. Monetary institutes, which were formerly common in French colonies, differ from currency boards in that they are not required to maintain a 100 per cent reserve ratio, although they must still maintain a high ratio (e.g. 50 per cent), and they may conduct open-market operations if their reserves permit. In some cases they may also have the power to regulate banks. In some French, Belgian and Portuguese colonies, there used to be private commercial banks which held a statutory monopoly of note issue in which they were required to maintain a fixed exchange rate between their currency and that of the ruling power.

Despite the faults of central banking, it became increasingly common during the period of the study. In 1950 there were 70 central banks in the world, but in 1993 there were 145. Dr Schuler suggests that this was partly for theoretical reasons and partly due to political factors. The consensus among economists is that a central bank is necessary because a banking system needs a lender of last resort, although Dr Schuler argues that this causes more problems than it solves and there are actually more banking crises in countries with central banking. In the political field, a central bank serves as a national status symbol, and it is also a useful way of funding budget deficits. Once established, central banks continue to exist because they are powerful lobbies.

The reasons for the difference between developed countries and developing countries make interesting reading. One factor which Dr Schuler points out is that all the developed countries in the study were democracies except Spain under Franco, and elections enabled the public to put pressure on politicians to keep inflation down, while many of the developing countries were ruled by dictators who were able to ignore public opinion. However, there are also more subtle factors relating to differences in wealth. Inflation harms private creditors but benefits the government and the central bank, because it reduces the value of debt. In developed countries there are millions of people who are rich enough to have substantial investments, so they, or the institutions in which they invest, can lobby the government effectively enough to counteract the influence of the central bank. Developing countries, on the other hand, are poorer, with less private wealth, so the central bank is much more dominant in the financial system, and no other institutions are big enough to challenge its power. Developing countries also find it harder to borrow money on financial markets, because they have a poorer record of repayment, so their governments have a stronger incentive to fund budget deficits by using the central bank to print money.

A significant new development is that three developing countries have recently gone against the prevailing trend and abandoned central banking, replacing it with what Dr Schuler calls "currency-board-like systems". (What he means, although the text does not make this completely clear, is that their central banks are still called banks, but are required to act like currency boards by backing their issues with foreign reserves.) Argentina was the first to do so, in 1991, when it linked the peso to the US dollar. Estonia followed in 1992 by replacing the Soviet rouble with the kroon, which was linked to the Deutschemark. Both countries succeeded in stopping hyperinflation, and their example inspired Lithuania to link its currency to the US dollar in 1994. Dr Schuler ends by advising other developing countries to do the same thing.

The ideal solution to the problem of inflation would, of course, be privatisation of money. Dr Schuler mentions this in passing, and he has written about it at greater length elsewhere. (See The Experience of Free Banking, edited by Kevin Dowd, published by Routledge, London, 1992.) However, this is too radical an idea to be politically possible today, and it will remain politically impossible for a few years yet. In the meantime, anything which reduces inflation is better than nothing. Dr Schuler's proposals have been shown to be feasible in practice. Although they are not applicable to British conditions, they could do millions of people a lot of good.

Roderick Moore